Brokers work at the Stock Exchange in Madrid yesterday. (Photo: AP)

MADRID, Spain

Investors sold off government bonds from Spain, Portugal and Italy on yesterday amid worries that Europe’s debt crisis has not been contained by Ireland’s bailout but will force more expensive rescue efforts.

The yields on Spain’s 10-year bonds jumped as high as 5.7 per cent, a euro-era record difference of 3.05 percentage points against the benchmark German 10-year bond. That compared with 2.67 points on Monday and below 2.00 points just a week ago.

The spread on Italy’s 10-year bond, meanwhile, reached 210 points, also the highest since the launch of the euro, before easing back somewhat. Portugal, whose yields soared last week, likewise saw its spread edge higher.

“Ireland’s bailout package has clearly failed to stop the rot in the eurozone markets and if anything it has focused attention on other countries in the periphery,” said Mitul Kotecha, analyst at Credit Agricole CIB.

The continued market turmoil “will come as a bitter blow to European officials who had hoped that it would help to turn sentiment around,” he said.

Jose Manuel Campo, economy secretary at the Spanish finance ministry, downplayed the market turbulence, describing it as “disproportionate.”

“It’s not necessarily worrying,” he told a parliamentary commission but added that it would be of concern if it continued for some time as it would then make loans to the public more expensive.

He said investors’ lack of confidence “is poorly justified and based on a short term analysis,” pointing out that there were major differences between Spain and Greece, Ireland or Portugal.

Spain and Portugal, deemed the next weakest links in the eurozone economy, have continually denied they will need outside help but investors have become increasingly skeptical that the series of bailouts will stop.

At the heart of the problem is that the austerity measures these countries need to take to reduce their deficits threaten to backfire by weakening economic growth and hurting state revenues. That is what’s happening in Greece, which has been able to drastically cut its spending but is struggling to raise tax income as economic and corporate activity wilts.

“It is clear that the market is aware of the tightrope that ‘peripheral’ governments are walking,” said Neil Mellor, currency strategist at Bank of New York Mellon.

While rescuing Portugal would be about as costly as Greece or Ireland, who each represent less than two per cent of the eurozone economy, a Spanish bailout would test the limits of Europe’s finances. It accounts for over a tenth of the eurozone economy, and Italy is even larger.

Portugal’s central bank warned yesterday that the financial system is facing “serious challenges,” as foreign concerns about public, private and corporate debt have made it harder for Portuguese banks to raise money on international markets.

Continuing to request financing from the European Central Bank is “unsustainable,” the bank warned, saying banks should adopt a commercial policy of encouraging saving to ensure their liquidity.

Traders worry that instability in Portugal could easily cross the border into Spain.

Spanish Prime Minister Jose Luis Rodriguez Zapatero has vigorously defended the nation’s economy and finances. He blames the bond market problems on speculators looking to make money on Spain in the short term and said they would be proven wrong.

But former Spanish premier Felipe Gonzalez, who chairs an EU Reflection Group that analyzes the bloc’s future, felt the ECB could help.

“If the European Central Bank were to do even a third of what the Federal Reserve does — having almost double the number of citizens and gross production 10 or 15 per cent more than the United States — with a third of the effort in buying public debt, this speculation would end,” said Gonzalez on Tuesday.

He warned that if Europe did not get ahead of the markets, the cases of Ireland and Greece would be repeated and in the end the entire 27-nation group would be contaminated.

Zapatero maintains Spain’s plans to reduce its deficit are being fulfilled and noted that the country’s total debt at roughly 60 per cent of GDP was still 20 percentage points below the European average. By contrast, Italian debt is expected to top 118 per cent of GDP this year, though its bonds are considered safer because they are not owned — and therefore speculated upon — by foreign investors to the same extent.

Still, the country is struggling to emerge from a near two-year recession and has a eurozone high unemployment rate of near 20 per cent. There is also concern that the effort to slash a swollen deficit from 11.2 per cent of GDP in 2009 to within the EU limit of three per cent by 2013 will prove too difficult.

The European Commission said earlier this week it was doubtful that Spain, Portugal and Ireland would meet their deficit targets and said more austerity measures might be needed.

Spanish Finance Minister Elena Salgado insisted yesterday that Spain would reach the deficit target no matter what and ruled out more austerity measures for fear of damaging growth.

She acknowledged that the Irish bailout did not seem to be sufficient to qualm fears and blamed that country’s bank problems for the current speculation and the threat to the euro currency.

Like Spain, Portugal’s government has repeatedly insisted that its austerity program next year will be enough to restore its fiscal health.

However, that line was used by the Greek and Irish governments as well before they finally accepted bailout packages. Investors fear a likely economic downturn because of the belt-tightening will make it harder for the Portuguese to meet their debt obligations.

Madrid’s main stock index, which has had more than a week of negative trading and saw a sharp drop on Monday, was down 0.7 per cent in early afternoon trading, while Portugal’s main index was 1.0 per cent lower.